The global financial crisis was the product of a �perfect storm" brewed by bringing together a number of economic pathologies: wanton securitisation, fundamental flaws from rating agencies and regulatory failures. (Buiter 2007) A series of complex and interlinked events can be traced to being the origin of the global financial crisis. The purpose of this paper is to discuss the main causes of the global financial crisis and possible measures that can be taken by the UK government to reduce the risk of another crisis occurring.
For most of the 20th century, the United States was the world`s leading economic power; having a great influence on the economies of the rest of the world. Large corporations- mostly manufacturing firms were the core of the U.S. economy, demonstrating their power through expansion choices, community connection and employment practices. Manufacturing corporations gradually disappeared and in their place service based corporations rapidly sprung up. This marked the transition from industrialism to post industrialism, thus displacing large manufacturing corporations as the organizing principle of the U.S. and the global economy. (Davies 2009) The post-industrial era was marked by a pronounced portion of the labour force being involved in services and no longer in agriculture or manufacturing. (Bell 1973), cited in Davies (2009, p.29) There was a reduction in the share of manufacturing employment in all developed countries; the most rapid de-industrialization took place in the UK and U.S. and the ratio of service-sector to industrial employment showed rapid increase over the period 1970-90. (Aoyama & Castells, 2002) Off-shoring and mass production became the order of the day in the manufacturing world which meant fewer firms and an increase in job losses in the home countries of these manufacturing firms. In the U.S, the largest corporate employer of labour became service based firms which had far more workers than the manufacturing industries did.
This employment shift to services brought changes to wages and pensions payment, benefits received and tenures. The wages were lower, no long term employment, less advancement in career through the job ladders, no job security and no generous health and retirement benefits. (Aoyama and Castells 2002) Pension financing became portable plans that are termed 'defined-contribution' in which employees and firms both contributed to an individually owned account which was invested and could be rolled over if the employee changed jobs. (Cobb 2008; Hacker 2006), cited in Davies (2009, p.31) Households enjoyed the flexibility of their pension plans and appreciated the short term employment; they often worked more than one job at a time, creating more money in their portable pension plans and more money to invest. These huge portable pensions funds were managed by various mutual funds, banks and investment banks. The mutual fund industry which was the primary point of investment for these defined-contribution pensions grew tremendously with the increase in portable pension plans. Better returns (than other savings funds) were offered by mutual funds; this attracted a lot of households to invest their pensions there. Pension investing became a big business dominated by institutional investors. These large pools of pension money were invested in the shares of corporations. There was a concentration of ownership in the hands of a few financial intermediaries as more and more corporations became partly owned by institutional investors. The focus of these institutional owners was return on investment (to give back to their numerous investors), (Davies 2009) which translates to increase in share price. Share price became the most relevant measure of corporate performance. Households changed jobs or had more than one job and wanted high returns from their portable pension plans, institutional investors wanted high returns from their investments in corporations and corporations wanted to increase the value of its shares to satisfy their investors, thus creating a vicious circle of profit pressure and employment instability. Restructuring of corporations by outsourcing to locations where resources were very cheap, specializing rather than diversifying their business and adopting network forms that further weakened the bonds between workers and firms were efforts made to 'unlock value' and increase share price. (Davies, 2009)
Banks also joined in this new fad of restructuring causing a transformation of the traditional model of banking. Traditionally, banks would raise funds, screen borrowers and lend out money to those approved. The banks would bear the loss if anyone defaulted. This system provided good incentives for banks to carefully assess the creditworthiness of borrowers. In the new system, banks (and brokers) started originating the mortgages and selling them off. (Allen and Carletti 2009) Banks and brokers pushed up mortgage sales because they were paid based on the number of mortgages approved. (Crotty 2008) Their new incentive was to sell as many mortgages as possible and since it was being sold off, if anyone defaulted it wasn`t going to be their problem. The whole process of checking the quality of the borrowers broke down. (Allen and Carletti 2009) The sold mortgages went through a process called securitization, which involves turning an asset, such as mortgages or credit card debt, into a financial instrument that can be traded in the capital market. A mortgage-backed bond is one form of securitization in which a large number of mortgage loans are grouped together and then divided into bonds that were believed to have safer returns. This allowed banks to have free funds for additional lending and it generally lowered the cost of taking out a mortgage. Securitization then went beyond mortgage loans to auto-loans, credit card debts, corporate loans, life insurance policies and anything with an income stream. (Davies 2009) The general idea was to minimize risk by separating credit risks, 'slicing and dicing' so that those risks can be transferred to those most willing and capable of absorbing them . .(Volcker, 2008), cited in Crotty(2008, p.8) Mortgage ownership became more dispersed as bond holders were spread round the world. Owners of mortgage include global institutional investors like pension funds. Thus, making households become both investors in (through pensions in mutual funds) and issuers of securities. (Davies, 2009) This web of securities was so complex and non-transparent, that they could not possibly be priced correctly and the impact of weakness in one market on the entire securities network was not understood.
The weakness in the housing marketing was one of the reasons of the global financial crisis. In 2003, the monetary policies of the U.S were changed favouring a cut down in interest rates and creating an incentive to borrow and buy houses (which were constantly growing in price at that time). The aggregate saving rate fell to zero, since people stopped saving and many borrowed to finance consumption. When there was a big fall in the prices of houses, people realized they had saved too little and that their properties were worth far less than the loans, this led to an increasing number of people defaulting on their loan. (Allen and Carletti 2009) These monetary and fiscal policies can be traced as part of the root of the global financial crisis, but also as a result of the irresponsible behaviour of private lenders and borrowers; and the excessive risks that were taken fuelled by cheap and easy access to money, which made possible the housing boom. (James et al. 2008)
Are transparencies in the financial markets and better designed rating agencies key to preventing the global financial crisis from happening again? (Buiter 2007) The UK government should ensure separation of retail, thus making banks to return to the private sector, in a profitable way. Ethics and risk training for all bankers should be put in place. The banking sector will then be a highly competitive sector with a few entry barriers and there will be a rebirth of mutual funds with regulations and regulators being finely tuned to prevent the banking risks from arising. (Hudson and Priddy 2009) Another possible measure would be to encourage a saving culture, so that public and private sector pension provision would be on equal grounds. Savings products and financial advice should be priced transparently. (Hudson and Priddy 2009)
There should be a transparent and fair system of taxation. There should also be the widespread limited liabilities for unauthorized or incorrect payments made online. A failure in corporate governance should be avoided by placing more focus on the performance of corporate governance than on its regulatory abidance. (Hudson and Priddy 2009)
This essay has discussed the main causes of the global financial crisis using a step approach starting from the change in the labour market to the changing pensions system and ending with burst of the housing bubble. The possible measures that the UK government could take to reduce the risks of another crisis were also discussed.
Aoyama,Y. and Castells, M. (2002). 'An Empirical Assessment of the Informational Society: Employment and Occupational structures of G-7 countries', 1920-2000. International Labour Review 141(1-2), p.123-159
Allen, F. And Carletti, E. (2009). 'The Global Financial Crisis'. An address to the Wharton Finance Club, 2009, pp.1-43
Buiter , W. (2007). 'Lessons from the 2007 financial crisis'. Centre for Economic Policy Research discussion paper accessed on http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1140525##.
Crotty, J. (2008), 'Structure causes of the global financial crisis: A Critical Assessment of the New Financial Architecture', political economy research institute, (180), pp. 1-62
Davies, G. F. (2009). 'The Rise and fall of Finance and the End of the society of organizations'. The Academy of Management Perspectives 23(3), pp.27-44
Hudson, V. and Priddy, S. 2009. Nine Steps to Financial Stability. Association of Chartered Certified Accountants, 2009, pp. 3-8
James, W. E. et al. 2008. The US financial crisis, Global Financial Turmoil, and Developing Asia: Is the Era of High Growth at an End? (139), pp. 1-85 0940284
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